fomc 20071211 blue book 20071206

Content last modified 02/07/2013.

Prefatory Note The attached document represents the most complete and accurate version available based on original files from the FOMC Secretariat at the Board of Governors of the Federal Reserve System. Please note that some material may have been redacted from this document if that material was received on a confidential basis. Redacted material is indicated by occasional gaps in the text or by gray boxes around non-text content. All redacted passages are exempt from disclosure under applicable provisions of the Freedom of Information Act.

CLASS I FOMC - RESTRICTED CONTROLLED (FR)

DECEMBER 6, 2007

MONETARY POLICY ALTERNATIVES

PREPARED FOR THE FEDERAL OPEN MARKET COMMITTEE BY THE STAFF OF THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

CLASS I FOMC – RESTRICTED CONTROLLED (FR) DECEMBER 6, 2007

MONETARY POLICY ALTERNATIVES

Recent Developments

Summary

(1) After showing some signs of improvement in late September and October,

conditions in financial markets worsened over the intermeeting period. Despite

economic data releases that were on balance only slightly weaker than expected,

Treasury yields and the expected path for the federal funds rate fell sharply amid

reports of sizable losses at several large financial institutions and increased concerns

over the economic outlook. Short-term Treasury instruments benefited from flight-

to-quality flows as investors reduced their exposure to risky assets. Heightened

worries about counterparty risk, as well as the effects of balance sheet constraints and

liquidity pressures, affected interbank funding markets and commercial paper markets,

where spreads over risk-free rates rose to levels that were, in some cases, higher than

those seen in August. Strains in those markets were no doubt exacerbated by

concerns related to year-end pressures. In longer-term corporate markets, both

investment- and speculative-grade credit spreads widened considerably; issuance

slowed but remained strong. Equity prices declined, on net, with financial stocks

especially hard hit. In housing finance, subprime mortgage markets stayed virtually

shut and spreads on jumbo loans apparently widened a good bit further. Spreads on

conforming products also increased, following reports of sizable losses and

consequent reduced capital ratios at the housing GSEs.

Monetary Policy Expectations and Treasury Yields

(2) The FOMC’s decision at its October meeting to reduce the target federal

funds rate by 25 basis points to 4½ percent was largely expected by market

participants, although the assessment that upside risks to inflation balanced the

downside risks to growth was not fully anticipated and apparently led investors to

revise up slightly the expected path for policy.1 The release of the FOMC minutes,

including the summary of economic projections, elicited only a modest market

reaction. Similarly, data releases—which apparently came in, on balance, only slightly

weaker than investors expected—left policy expectations little changed on net.

However, concerns about the potential adverse effects on credit availability and

economic growth of sizable losses at large financial institutions and of financial

market strains in general pushed the expected path of policy down substantially.

Market participants have priced in a total of about 150 basis points of policy easing by

early 2009 (Chart 1), about 80 basis points more than at the time of the October

meeting. Judging from quotes on federal funds target binary options, investors are

virtually certain of a rate cut at the upcoming FOMC meeting, and assign about

60 percent probability to a quarter-point cut and 35 percent probability to a half-point

easing. Respondents to the Desk’s recent survey of primary dealers also anticipated

easing, but placed lower odds on a 50 basis point cut than suggested by market

1 The effective federal funds rate averaged 4.50 percent over the intermeeting period, but the rate was again more volatile than usual. The intraday standard deviation over the period averaged 25 basis points, significantly higher than was typical before August, and the root mean squared deviation of the daily effective rate from the target was likewise elevated. U.S. branches and agencies of foreign banks continued to exhibit fairly strong demand for federal funds, especially in the morning. Once these institutions locked in their daily funding, federal funds tended to trade lower to varying degrees over the afternoon. As a consequence, judging the appropriate amount of reserves to provide to the market was more difficult than usual. Over the period, the volume of long-term RPs increased by $8 billion dollars to $20 billion, reflecting an $8 billion 43-day repurchase agreement that was conducted on November 28 and crosses year-end. The Desk announced that the operation was the first of several intended to help satisfy term funding needs and that the Desk planned to provide sufficient liquidity to resist upward pressure on the funds rate around year-end. The Desk did not purchase any securities outright, but on December 6 redeemed $5 billion in Treasury bills and boosted the level of short-term repos outstanding. This shift was designed to provide greater flexibility to reduce the level of balances in the event of significant borrowing from the discount window.

Class I FOMC - Restricted Controlled (FR) 2 of 43

Chart 1Interest Rate Developments

Note. Vertical lines indicate October 30, 2007. Last daily observations are for December 6, 2007.

2008 20092.5

3.0

3.5

4.0

4.5

5.0Percent

December 6, 2007October 30, 2007

Expected Federal Funds Rates*

*Estimates from federal funds and Eurodollar futures, with an allowance for term premiums and other adjustments.

3

5

7

9

11

13

2002 2003 2004 2005 2006 2007 40

80

120

160

200

240

280

320

Percent Basis points

Ten-Year Treasury (left scale)Six-Month Eurodollar (right scale)*

Implied Volatilities

Daily

*Width of a 90 percent confidence interval estimated from the termstructures for the expected federal funds rate and implied volatility.

Oct.FOMC

Implied Distribution of Federal Funds Rate Six Months Ahead*

0.75 1.25 1.75 2.25 2.75 3.25 3.75 4.25 4.75 5.25 5.75 6.25

Recent: 12/06/2007 Last FOMC: 10/30/2007

0

5

10

15

20

Percent

*Derived from options on Eurodollar futures contracts, with term premium and other adjustments to estimate expectations for the federal funds rate.

2004 2005 2006 20070

1

2

3

4

5

6

7Percent

Ten-YearTwo-Year

Nominal Treasury Yields*

Daily

*Par yields from a smoothed nominal off-the-run Treasury yield curve.

Oct.FOMC

-100

-80

-60

-40

-20

0

20Basis points

1 2 3 Years ahead

5 7 10

Change in Implied One-Year Forward Treasury Ratessince Last FOMC Meeting*

*Forward rates are the one-year rates maturing at the end of the year shownon the horizontal axis that are implied by the smoothed Treasury yield curve.

1.5

2.0

2.5

3.0

3.5

4.0

2004 2005 2006 2007 30

40

50

60

70

80

90

100

110

120

130Percent $/barrel

Next Five Years (left scale)Five-to-Ten Year Forward (left scale)Spot WTI (right scale)

Inflation Compensation and Oil Prices*

Daily

*Estimates based on smoothed nominal and inflation-indexedTreasury yield curves and adjusted for the indexation-lag (carry) effect.

Oct.FOMC


quotes. Most respondents predicted that the Committee will put more emphasis on

downside risks to growth than in the October statement. In addition, some dealers

expect that the spread of the primary credit rate over the target funds rate will be

narrowed. Uncertainty about the path for policy increased slightly, on net, from its

already high levels, and the option-implied distribution of the federal funds rate six

months ahead retained a substantial skew to the downside.

(3) Yields on two-year nominal Treasury securities fell about 80 basis points, on

net, over the intermeeting period, about in line with the revision to policy

expectations. Ten-year Treasury yields dropped about 30 basis points. The

steepening of the yield curve owed mostly to sharply lower short- and intermediate-

term forward rates, consistent with investors’ apparently more pessimistic outlook for

economic growth. TIPS yields fell by less than their nominal counterparts, implying

modest declines in inflation compensation at both the five-year and longer horizons.

Money Markets

(4) After showing signs of improvement between the September and October

FOMC meetings, conditions in money markets subsequently worsened, with the

deterioration reflected partly in large premiums for funding over year-end. (See box

“Flight-to-Quality Flows and Year-end Pressures.”) Large financial institutions

reported an additional $35 billion in losses over the intermeeting period, and investors

appear concerned that even more writedowns may be forthcoming. Term bank

funding markets came under considerable pressure, and spreads of term libor and

federal funds rates over those on comparable-maturity overnight index swaps widened

sharply and now exceed their September peaks. Conditions in European interbank

money markets also deteriorated over the intermeeting period, as term spreads

expanded by about 30 basis points in euro markets and in sterling markets. In the

United States, outstanding asset-backed commercial paper (ABCP) continued to


- Flight-to-Quality Flows and Year-end Pressures

Substantial actual and anticipated losses at financial firms increased pressures on institutions’ liquidity and balance sheet capacity and boosted investors’ concerns about counterparty credit risk over the intermeeting period. These developments contributed to renewed flight-to-quality flows and, in money markets, generated year-end pressures which have largely been absent in recent years. Investors have apparently shifted their demand toward safe securities such as Treasury bills and away from risky assets such as uncollateralized loans to banks. Despite an increased supply of bills in November, bill yields have declined sharply over recent weeks amid heavy inflows to money market mutual funds that hold only Treasury and agency securities. The spread of the three-month overnight indexed swap (OIS) rate over the comparable-maturity Treasury bill yield―a plausible proxy for safe-haven demands―climbed about 50 basis points over the intermeeting period, though it remained below the peak reached in August. Meanwhile, the spread of three-month libor over the corresponding OIS rate―a measure of term premiums in short-term funding markets―widened about 60 basis points to its highest level during the recent period of financial market turmoil. Some tiering was evident in uncollateralized funding markets: Domestic and large European institutions were able to borrow at rates close to the libor fixing, but smaller European institutions faced a substantial premium.

While forward rates suggest that concerns about counterparty credit risk are expected to persist well into next year, market stress is particularly acute in rates that span the turn of the year. The one-week forward Treasury bill yield that encompasses the year-turn has fallen to around 1 percent, apparently reflecting financial institutions’ desire to show more of the safest assets on their year-end books. Markets expect the provision of liquidity by the Desk to be generous over year-end: A comparison of futures on the effective federal funds rate to quotes on target funds rate options implies that investors expect federal funds to trade about 100 basis points below the target on the last day of the year. Nevertheless, pressures on banks’ balance sheets and concerns about liquidity and counterparty credit risk have made financial institutions reluctant to lend over year-end and have fueled precautionary demand for such funding. As a result, the spread of one-month libor over the corresponding OIS rate jumped nearly 50 basis points as the maturity date on a one-month deposit crossed into the new year. The implied premium for funding on the last day of the year is about 700 basis points at an annual rate―a level that is extremely high by the standards of recent years, though still a little below that reached in the runup to Y2K. One-month libor is now 24 basis points above the primary credit rate, yet term borrowing at the discount window remains limited, likely owing in part to perceived stigma of using the primary credit facility. Significant year-end pressures can be observed in the commercial paper market as well.


contract in November (Chart 2), and spreads of ABCP yields over those on

comparable unsecured CP widened considerably. In the unsecured sector, spreads on

lower-rated thirty-day paper also increased substantially, particularly as the term

extended over year-end, but overnight spreads widened only modestly. The shares of

unsecured CP and ABCP issued over year-end are about in line with their year-ago

levels. The outstanding amount of European asset-backed commercial paper

declined, as some money market funds reportedly scaled back holdings of ABCP in

advance of year-end.

(5) Money market mutual funds experienced heavy inflows over the

intermeeting period, reflecting in part safe-haven demands. Inflows were directed

primarily toward funds that invest only in Treasury and agency obligations,

contributing to a sharp fall in Treasury bill rates. Similarly, strong demand for

Treasury collateral drove the overnight Treasury general collateral repo rate well

below the federal funds rate. Lending from the SOMA securities portfolio has

increased in recent weeks, and the Desk relaxed some limits on the securities lending

program in response to the reduced liquidity in Treasury markets.2

Capital Markets

(6) Yields on investment-grade corporate bonds edged up over the intermeeting

period, while those on speculative-grade bonds increased appreciably. As a result,

spreads on both investment- and speculative-grade bonds over comparable-maturity

Treasury securities rose markedly and are now at their highest levels in several years.

2 On November 26, the Desk announced some modest, temporary changes to the Securities Lending Program. Individual dealers are now limited to 25 percent of the total amount of any particular security available for borrowing with a maximum of $750 million per issue, up from 20 percent and $500 million, respectively; the supply available for borrowing has been increased from 65 to 90 percent of the SOMA’s holdings of an individual issue; and all securities with maturity greater than six days are eligible for borrowing versus the previous limit of securities maturing in greater than thirteen days.


Chart 2Asset Market Developments

Note. Vertical lines indicate October 30, 2007. Last daily observations are for December 6, 2007.

Jan. Mar. May July Sept. Nov.2007

700

800

900

1000

1100

1200

1300

1400Billions of dollars

ABCPUnsecured

Weekly (Wed., s.a.)

Commercial Paper Outstanding

Oct. FOMC

Last weekly observation is for December 5, 2007.

50

100

150

200

250

300

350

400

2001 2002 2003 2004 2005 2006 2007 0

250

500

750

1000

1250

Basis points Basis points

Ten-Year BBB (left scale)Ten-Year High-Yield (right scale)

Oct.FOMC

Corporate Bond Spreads*

Daily

*Measured relative to an estimated off-the-run Treasury yield curve.

May June July Aug. Sept. Oct. Nov. Dec.2007

100

150

200

250

300

350

400Basis points

Series 8Series 9

Oct. FOMCDaily

LCDX Spreads

Note. LCDX Series 8 Index started trading May 22, 2007. LCDX Series 9Index started trading October 3, 2007. The Series 9 Index reportedlyincludes a somewhat riskier set of loans.Source. Markit.

2001 2002 2003 2004 2005 2006 2007 50

70

90

110

130

150

170Index(12/31/00=100)

WilshireDow Jones Financial

Oct.FOMC

Equity Prices

Daily

2001 2002 2003 2004 2005 2006 2007 0

10

20

30

40

50

60Percent

S&P 500 (VIX)

Implied Volatility

Daily Oct.FOMC

2000 2001 2002 2003 2004 2005 2006 2007

0

50

100

150

200

250

300

350

400Basis points

FRM1-Year ARMJumbo-Conforming

Oct.FOMC

Mortgage Rate Spreads

Weekly

Note. FRM spread relative to 10-year Treasury. ARM spread relativeto 1-year Treasury. Last weekly observation is for December 5, 2007.Source. Freddie Mac, Inside Mortgage Finance.


The higher spreads appear to reflect both a reassessment of the credit quality of

nonfinancial corporations, perhaps induced by concerns about prospects for the

economic expansion, and an increase in investors’ risk aversion. Bond issuance

slowed in November but remained strong. In the leveraged loan market, the pipeline

of underwritten loans awaiting syndication diminished early in the period but is still

substantial. Secondary market bid prices for leveraged loans dropped significantly in

November and are now below their levels in early August. An index of credit default

swaps on leveraged syndicated loans (the LCDX) rose about 40 basis points, on net,

over the intermeeting period. Broad-based equity indexes were volatile and ended the

period down 1½ to 2 percent. Financial stocks were especially hard hit, dropping

about 5 percent. The spread between the twelve-month forward trend-earnings-price

ratio for S&P 500 firms and a real long-run Treasury yield—a rough measure of the

equity premium—widened, consistent with investors pulling back from risk. Option-

implied volatility on the S&P 500 remained elevated, at times rising back to near its

August peaks. Yield ratios for the municipal bonds moved up sharply on investor

concerns about the financial health of bond insurers and possibly the fiscal outlooks

for state and local governments.

(7) Credit availability for jumbo-mortgage borrowers continued to be tight, and

the spread between the offer rates on prime jumbo fixed-rate mortgages and

comparable conforming loans rose from already high levels. Rates on conforming

mortgages fell, although not as much as yields on comparable-maturity Treasury

securities, implying a widening of spreads. Issuance of residential mortgage-backed

securities (RMBS) backed by nonconforming loans continued to fall, while issuance of

those backed by conforming mortgages was robust. Secondary markets for non-

agency RMBS remained largely inactive. ABX spreads for most tranches widened

further for most of the intermeeting period, as investor confidence in subprime

RMBS and associated credit ratings continued to wane. However, ABX spreads


dropped sharply late in the period amid reports that a plan to freeze rates on some

subprime mortgages was close to agreement. Spreads on agency MBS rose sharply

after Fannie Mae and Freddie Mac announced large third-quarter losses, raising

concerns about their ability to offer refinancing options to some subprime borrowers.

Subsequently, these spreads retraced a substantial part of the increase. (See box

“Recent Developments at Housing Intermediaries.”)

Market Functioning

(8) In addition to the short-term funding impairments noted earlier, trading

conditions were strained in a range of markets over the intermeeting period.

Functioning in the Treasury bill market was notably impaired at times, and bid-asked

spreads on bills generally remained very wide. Bid-asked spreads widened

substantially less for Treasury coupon securities, and while investors were willing to

pay significant premiums to hold on-the-run securities, overall liquidity remained

ample in that market. Liquidity was somewhat diminished in corporate markets:

Trading volumes declined significantly in November, a proxy for bid-asked spreads

on corporate bonds widened, and trades appeared to have a larger-than-normal

impact on prices. Bid-asked spreads for leveraged syndicated loans rose quite sharply

over the intermeeting period but remained below the peaks reached in early August.

Judging from the abnormally wide range of quotes submitted by various dealers for

the same reference entities, liquidity and price discovery were also impaired in CDS

markets, especially for financial institutions. The subprime RMBS market remained

shut with virtually no trading taking place. Strains were also evident at times in the

market for agency MBS, where bid-asked spreads widened noticeably following the

reports of large losses by the housing GSEs before retracing part of that move more

recently. That market may also have been affected by year-end pressures as some

investors are reportedly reluctant to hold mortgage products in their portfolios at the


Recent Developments at Housing Intermediaries

Fannie Mae and Freddie Mac reported third-quarter losses of $1.4 billion and $2 billion, respectively, over the intermeeting period, reflecting in part an increase in actual and projected credit losses on the mortgages they guarantee or hold. On the news, credit default swap (CDS) spreads on the two agencies spiked and spreads on Fannie’s and Freddie’s MBS also rose sharply, albeit against a backdrop of heavy issuance. Both CDS and MBS spreads later retraced a substantial portion of their increases as market sentiment was improved, in part, by news that Freddie Mac was able to raise $6 billion in fresh capital and reports of an industry agreement to delay by several years the reset of interest rates on certain subprime mortgages. Fannie Mae also began the process of raising capital this week, and investor interest was reportedly high. While it is improbable that all of the recent increase in MBS spreads will be passed on to borrowers, particularly because part of the increase may prove transitory, conforming borrowers may face higher spreads of mortgage rates over Treasuries in the future than in recent years. Potentially adding further to the cost of mortgage credit is the fact that Fannie Mae and Freddie Mac have increased the fees they charge to guarantee mortgages pooled into agency MBS. That rise likely reflects waning competition from other securitizers as well as increased actual and projected credit losses. The GSEs also appear to have imposed sizable additional fees on a variety of riskier loans, such as those with loan-to-value ratios greater than 70 percent extended to borrowers with lower credit scores.

Other large mortgage lenders were subject to even stronger market pressures over the intermeeting period. For example, CDS spreads on Countrywide Financial Corporation spiked to very high levels—near 1000 basis points—as investors became concerned about the ability of the thrift to fund its operations and about its overall solvency. Countrywide had borrowed in excess of $50 billion from the Federal Home Loan Bank of Atlanta by the end of the third quarter, putting it close to the limit of 50 percent of borrower assets beyond which Home Loan Banks are typically very reluctant to lend to their members. CDS and debt spreads on the Home Loan Banks also spiked, as investors reportedly became uncomfortable with the concentration of their lending to a few large borrowers (especially Countrywide and Washington Mutual). A higher cost of Home Loan Bank debt has the potential to translate into higher funding costs for their borrowers.


close of their fiscal year. The FX swap market remained strained; bid-asked spreads

continued to be larger than usual, the average size of trades diminished, and the

capacity for market-making was impaired as some major market makers dropped out.

Foreign Developments

(9) Concerns about financial fragility and its potential impacts on economic

growth appeared to affect many foreign financial markets during the intermeeting

period. Headline stock price indexes dropped 3 to 5 percent in Europe, Canada, and

Japan, on net, with financial stocks registering especially large declines in many cases

(Chart 3). Stock prices also fell sharply in many emerging market economies; in China

share prices dropped more than 15 percent, reacting in part to reports that additional

steps may be taken to cool the domestic economy. Consistent with a pullback by

investors from risky positions, yields on long-term government securities in industrial

countries fell 10 to 40 basis points, while EMBI+ spreads on sovereign bonds of

major emerging market economies widened noticeably. The trade-weighted foreign

exchange value of the dollar against major currencies moved up about 1¼ percent, on

balance, over the intermeeting period.3 The dollar rose more than 6½ percent against

the Canadian dollar on signs of slower growth in Canada; on December 4, the Bank

of Canada announced a 25 basis point cut in its target for the overnight interest rate,

citing lower inflation and concerns that effects on Canada from the U.S. sub-prime

crisis will last longer than previously thought. The dollar gained about 2½ percent

versus the pound; late in the period, the Bank of England also lowered its target

policy rate 25 basis points. In contrast, the dollar declined 3¾ percent and

1¼ percent against the yen and euro, respectively, while rising more than 6 percent

versus the Australian dollar, as carry trade positions were reported to have been

unwound in reaction to heightened financial uncertainties. The index of the dollar’s 3

.


Chart 3International Financial Indicators

Note: Vertical lines indicate October 31, 2007. Last daily observations are for December 6, 2007.

2004 2005 2006 2007 90

100

110

120

130

140

150

160

170

180

190

UK (FTSE-350)Euro Area (DJ Euro)Japan (Topix)

Stock Price IndexesIndustrial Countries

Daily

Index(12/31/03=100)

October FOMC

2004 2005 2006 2007 70

100

130

160

190

220

250

280

310

340

370

400

Brazil (Bovespa)Korea (KOSPI)Mexico (Bolsa)

Stock Price IndexesEmerging Market Economies

Daily

Index(12/31/03=100)

October FOMC

3.0

3.5

4.0

4.5

5.0

5.5

6.0

2004 2005 2006 20070.0

0.5

1.0

1.5

2.0

2.5

3.0

UK (left scale)Germany (left scale)Japan (right scale)

Ten-Year Government Bond Yields (Nominal)

Daily

Percent

October FOMC

2004 2005 2006 2007 82

84

86

88

90

92

94

96

98

100

102

104

106

108

110

112

BroadMajor CurrenciesOther Important Trading Partners

Nominal Trade-Weighted Dollar Indexes

Daily

Index(12/31/03=100)

October FOMC


value versus currencies of other important trading partners was about unchanged over

the period.

Debt and Money

(10) Domestic nonfinancial sector debt is estimated to be increasing at an annual

rate of about 7 percent in the current quarter, almost 2 percentage points less than in

the third quarter (Chart 4). The growth of nonfinancial business debt has slowed a bit

but remains strong on robust bond issuance and a small rebound in commercial

paper. Growth in C&I lending also remained rapid, as some previously committed

large syndicated loan deals reportedly were taken onto banks’ balance sheets.

Household mortgage debt growth is expected to slow this quarter, reflecting the

weakness in home prices, declining home sales, and tighter credit conditions for some

borrowers. Consumer credit appears to be expanding at a moderate pace this quarter.

(11) M2 advanced at an annual rate of about 5 percent in November. While

liquid deposits continued to grow slowly, heightened demand for safety and liquidity

appears to have boosted retail money market mutual funds. Small time deposits

continued to expand, evidently owing in part to high rates offered by some depository

institutions to attract retail deposits. Currency was about flat in November, probably

owing at least in part to an ongoing shift by some overseas investors from holding

dollars to holding other currencies.


Chart 4Debt and Money

Growth of Debt of Nonfinancial Sectors

Percent, s.a.a.r.

2006

2007

Q2Q3Q4

Q1Q2Q3Q4p

Total_____

8.8

8.37.28.6

8.07.28.97.1

Business__________

9.6

8.66.9

11.4

9.310.711.99.7

Household__________

10.3

11.28.78.4

7.17.66.94.9

p Projected.

-10

0

10

20

30

40

50

60

70

80

C&I LoansCommercial PaperBonds

Sum

Changes in Selected Components of Debt ofNonfinancial Business*

$Billions

2005 2006 Q1 Q2 Q3 Oct-Nov

2007

Monthly rate

*Commercial paper and C&I loans are seasonally adjusted, bonds are not.

e

e Estimated.

1991 1993 1995 1997 1999 2001 2003 2005 2007

-3

0

3

6

9

12

15

18

21

Growth of Debt of Household SectorPercent

Quarterly, s.a.a.r.

p Projected.

Q4pQ4p

ConsumerCredit

HomeMortgage

1995 1997 1999 2001 2003 2005 2007

-2

0

2

4

6

8

10

12

Growth of House PricesPercent

Quarterly, s.a.a.r.

Q3

OFHEO Purchase-Only Index

-4

-2

0

2

4

6

8

10

12

Growth of M2

s.a.a.r.Percent

2005 H1 H2 Q1 Q2 Q3 Q42006 2007

e

e Estimated.

0.25

0.50

1.00

2.00

4.00

8.00

1993 1995 1997 1999 2001 2003 2005 2007

1.8

1.9

2.0

2.1

2.2

2.3

M2 Velocity and Opportunity CostVelocityPercent

Quarterly

Opportunity Cost*(left axis)

Velocity(right axis)

*Two-quarter moving average.

Q3

Q3


Economic Outlook through 2009

(12) In response to more restrictive financial conditions, higher oil prices, and

weaker-than-expected economic data, the staff has marked down its outlook for the

growth of aggregate demand and lowered its assumption for the path of the federal

funds rate. The Committee is now assumed to reduce the target rate 25 basis points

at the December meeting and then another 25 basis points to 4 percent in the middle

of 2009, leaving the federal funds rate 75 basis points lower at the end of the forecast

period than in the October Greenbook. Even so, the staff expects longer-term

Treasury yields to reverse much of their recent declines as investors’ expectations for

sharper reductions in the federal funds rate move into alignment with the staff’s

assumption for monetary policy. As usual, stock prices are anticipated to rise at a

6½ percent annual rate. The real foreign exchange value of the dollar is assumed to

depreciate about 1½ percent per year. The price of crude oil is expected to decline

gradually but remain above the path in the October Greenbook. Against this

backdrop, the pace of economic expansion is projected to slow from about

2½ percent in the second half of 2007 to 1 percent over the first half of 2008 as the

housing correction deepens, growth of consumer spending slows further, and

business spending decelerates. Thereafter, real GDP growth gradually picks up,

returning to around the rate of potential GDP growth in 2009, as the decline in

residential investment abates and the drag on spending from tighter credit conditions

and higher energy prices wanes. The unemployment rate edges up through the

forecast period to 5 percent, a little above the staff’s 4¾ percent estimate of the

NAIRU. Boosted by the rise in oil prices in recent months, total PCE inflation climbs

to nearly a 3½ percent rate in the current quarter but then drops to 2 percent next

year and to about 1¾ percent in 2009 as oil prices edge down. Core PCE inflation,

which is projected to run about 2¼ percent in the current quarter and 2 percent for


2007 as a whole, inches down to just below 2 percent in 2009 as pressures on

resources ease and energy pass-through effects diminish.

Update on Medium-Term Strategies

(13) This section provides an update of the materials on medium-term strategies

for monetary policy that were presented in the October Bluebook. As shown in

Chart 5, the Greenbook-consistent measure of short-run r*—the value that would

close the output gap over the next twelve quarters—has shifted down nearly ¾ of a

percentage point and now stands at about 2.2 percent, roughly 40 basis points below

our estimate of the current real federal funds rate. This revision reflects the extent to

which less favorable financial conditions and higher oil prices than previously

expected are projected to restrain aggregate demand over the next three years. The

three model-based estimates of short-run r* range from about 1½ to 2½ percent, an

interval that is essentially unchanged from October.4

(14) Chart 6 depicts optimal control simulations of the FRB/US model using

the staff’s extension of the Greenbook forecast beyond 2009.5 In these simulations,

policymakers place equal weights on keeping core PCE inflation close to a specified

goal, on keeping unemployment close to the long-run NAIRU, and on avoiding

changes in the nominal federal funds rate.6 For an inflation goal of 1½ percent

(the left-hand set of charts), the optimal path of the funds rate averages a little less 4 The FRB/US model estimate of short-run r* has been revised downward by about ¾ percentage point, reflecting the model’s projection that some of the near-term weakness in aggregate demand will persist over the next few years. 5 This extension incorporates the same medium-term assumptions used to generate the illustrative extension discussed in the October Bluebook. The characteristics of the extension are described in the memo to the Committee by Robert Tetlow, “The Extended Greenbook Forecast,” December 5, 2007. 6 In conducting these simulations, policymakers and participants in financial markets are assumed to understand fully the forces shaping the economic outlook (as summarized by the extended Greenbook projection), whereas households and firms form their expectations using more limited information.


Chart 5Equilibrium Real Federal Funds Rate

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007-2

-1

0

1

2

3

4

5

6

7

8

-2

-1

0

1

2

3

4

5

6

7

8Percent

Note: Appendix A provides background information regarding the construction of these measures and confidence intervals.

Short-Run Estimates with Confidence Intervals

Actual real federal funds rateRange of model-based estimates70 Percent confidence interval90 Percent confidence intervalGreenbook-consistent measure

Short-Run and Medium-Run Measures

Current Estimate Previous Bluebook

Short-Run Measures

Single-equation model (2.5 (2.6

Small structural model (1.7 (1.6

Large model (FRB/US) (1.6 (2.3

Confidence intervals for three model-based estimates

70 percent confidence interval (0.4 - 3.4

90 percent confidence interval -0.4 - 4.4

Greenbook-consistent measure (2.2 (2.9

Medium-Run Measures

Single-equation model (2.3 (2.4

Small structural model (1.8 (1.9

Confidence intervals for two model-based estimates



TIPS-based factor model (2.0 2.1

Memo

Actual real federal funds rate (2.6 (2.9


Chart 6

Optimal Policy Under Alternative Inflation Goals

2007 2008 2009 2010 2011 20122.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0Percent

1½ Percent Inflation GoalFederal funds rate

Current BluebookOctober Bluebook

2007 2008 2009 2010 2011 20124.0

4.5

5.0

5.5

6.0

4.0

4.5

5.0

5.5

6.0Percent

Civilian unemployment rate

2007 2008 2009 2010 2011 20121.50

1.75

2.00

2.25

1.50

1.75

2.00

2.25Percent

Core PCE inflationFour-quarter average

2007 2008 2009 2010 2011 20122.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

2.0

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0Percent

2 Percent Inflation Goal

Current BluebookOctober Bluebook

2007 2008 2009 2010 2011 20124.0

4.5

5.0

5.5

6.0

4.0

4.5

5.0

5.5

6.0Percent

2007 2008 2009 2010 2011 20121.50

1.75

2.00

2.25

1.50

1.75

2.00

2.25Percent

Four-quarter average


than 4¾ percent through the end of 2009 before declining gradually to a plateau of

about 3¾ percent. With an inflation goal of 2 percent (the right-hand set of charts),

the optimal funds rate declines to 3¾ percent by the end of 2009 and then—as the

effects of the current financial strains continue to unwind—gradually rises

to 4¼ percent by the end of 2012. Compared with the October Bluebook, these

prescriptions are 50 to 75 basis points lower for the period to the end of 2009,

reflecting the same factors that account for the shift in the Greenbook-consistent

r* measure. With either inflation goal, over the next couple of years the path of the

unemployment rate is slightly higher than that shown in the last Bluebook and the

path for core inflation is about ¼ percentage point higher than in October, reflecting

in part the transitory effects of higher oil prices.

(15) As shown in Chart 7, the outcome-based monetary policy rule prescribes a

funds rate path that declines to 4 percent by the middle of next year and remains

between 4 and 4½ percent throughout the forecast period, about 25 to 75 basis points

lower than in the October Bluebook. According to financial market quotes, investors

anticipate that the funds rate will decline to 3¼ percent by the end of 2008 and then

rise to about 4 percent by the end of 2012. Compared with the previous Bluebook,

the 70 percent confidence interval for the funds rate path is a notch lower at the end

of 2012, suggesting a modest decline in the market’s assessment of the equilibrium

real interest rate over the medium run, and is down as much as 50 basis points over

the next two years. The near-term prescriptions from the simple policy rules

proposed by Taylor (1993, 1999) are little changed since the October Bluebook. The

first-difference rule—which does not require estimates of the levels of the output gap

or the equilibrium real interest rate—generates a flat funds rate path if the inflation

goal is 1½ percent or a 30 basis point cut by mid-2008 if the inflation goal is

2 percent.


Chart 7

The Policy Outlook in an Uncertain Environment

2007 2008 2009 2010 2011 20120

1

2

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4

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9

10

11

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1

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11Percent

Note: Appendix B provides background information regarding the specification of each rule and the methodology used inconstructing confidence intervals and near-term prescriptions.

FRB/US Model Simulations ofEstimated Outcome-Based Rule

Current Bluebook Previous Bluebook70 Percent confidence interval90 Percent confidence intervalGreenbook assumption

2007 2008 2009 2010 2011 20120

1

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11Percent

Information from Financial Markets

Expectations from forward contracts Previous Bluebook70 Percent confidence interval Previous Bluebook90 Percent confidence interval Previous Bluebook

Near-Term Prescriptions of Simple Policy Rules

1½ Percent 2 PercentInflation Objective Inflation Objective

2008Q1 2008Q2 2008Q1 2008Q2

Taylor (1993) rule 4.1 4.3 3.9 4.0

Previous Bluebook 4.0 4.1 3.7 3.9 Taylor (1999) rule 4.2 4.2 3.9 4.0

Previous Bluebook 4.1 4.2 3.9 4.0 Taylor (1999) rule with higher r* 4.9 5.0 4.7 4.7

Previous Bluebook 4.9 5.0 4.6 4.7 First-difference rule 4.3 4.3 4.1 3.8

Previous Bluebook 5.0 5.0 4.5 4.3

Memo2008Q1 2008Q2

Estimated outcome-based rule 4.1 4.1

Estimated forecast-based rule 4.1 4.0

Greenbook assumption 4.2 4.2

Fed funds futures 4.0 3.6

Median expectation of primary dealers 3.9 3.8


Short-Run Policy Alternatives

(16) This Bluebook presents three policy alternatives for the Committee’s

consideration, summarized in Table 1. Alternative A lowers the target federal funds

rate 50 basis points to 4 percent, Alternative B lowers the target 25 basis points to

4¼ percent, and Alternative C leaves the target unchanged at 4½ percent. In the

rationale paragraph, all three alternatives suggest that economic growth is slowing,

reflecting the intensification of the housing correction. (The characterization of the

economic situation will need to be reviewed in light of the employment report for

November, which will be released on December 7, the day after the publication of

this Bluebook.) Each of the alternatives references the recent softness in indicators of

business and consumer spending and acknowledges that strains in financial markets

have increased since the last FOMC meeting. The alternatives also note that the

stance of monetary policy should promote moderate growth over time, but

Alternatives A and C point to increased downside risks to growth. In light of the

leveling out of non-energy commodity prices over the intermeeting period, each

alternative suggests that “elevated” energy and commodity prices, along with other

factors, may put upward pressure on inflation, instead of referring to “recent increases

in energy and commodity prices.” The alternatives differ regarding assessments of

risks to growth and inflation. Alternative A characterizes the downside risks to

growth as roughly balancing the upside risks to inflation, repeating the assessment of

risks from the October statement. Alternative B avoids an explicit assessment of the

balance of risks and instead states that recent developments have increased the

uncertainty regarding the outlook. Alternative C concludes that the risks to growth

are the predominant policy concern and notes that “future policy adjustments will

depend on the outlook for both inflation and economic growth, as implied by

incoming information.” As usual, the Committee could combine language from

different alternatives.


Table 1: Alternative Language for the December 2007 FOMC Announcement

October FOMC Alternative A Alternative B Alternative C

Policy Decision

1. The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent.

The Federal Open Market Committee decided today to lower its target for the federal funds rate 50 basis points to 4 percent.

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/4 percent.

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 4-1/2 percent.

2. Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction. Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.

Incoming information suggests that the housing correction has intensified and that growth in business and consumer spending is softening. Moreover, strains in financial markets have increased in recent weeks. Overall, the outlook for the economy has weakened somewhat, and downside risks to growth have increased. Today’s action, combined with the policy actions taken earlier, should help promote moderate growth over time.

Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks. Today’s action, combined with the policy actions taken earlier, should help promote moderate growth over time.

As the Committee had anticipated, economic growth appears to be slowing, partly reflecting the intensification of the housing correction. Although strains in financial markets have increased in recent weeks and now pose greater downside risks to growth, the monetary policy actions taken earlier are expected to help promote moderate growth over time.

Rationale

3. Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.



Assessment of Risk

4. The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

The Committee views the downside risks to growth as the predominant policy concern. Future policy adjustments will depend on the outlook for both inflation and economic growth, as implied by incoming information.


(17) If the Committee judges that tighter financial conditions, higher oil prices,

and soft incoming data point to a weaker economic outlook than previously

anticipated, then it may deem a more accommodative stance of policy to be

appropriate and ease policy 25 basis points, as in Alternative B. The real federal

funds rate is nearly half a percentage point above its downwardly revised Greenbook-

consistent equilibrium value and a touch above the upper end of the range of model-

based estimates (Chart 5), suggesting that a reduction in the target funds rate may be

required to keep output near its potential. Several policy rules (Chart 7) also suggest

that further policy easing would be appropriate. Moreover, members might be

concerned about the risk of possible further deterioration in financial conditions,

particularly in the run-up to year-end, or about the potential for significant spillovers

from the housing sector to the broader economy. If so, they may judge that a policy

easing at this meeting might help insure against such developments. At the same

time, the Committee may believe that the risks to inflation associated with a 25 basis

point reduction in the target federal funds rate are modest, given recent readings on

core inflation and the current outlook for prices.

(18) After noting that “economic growth is slowing” and that “strains in

financial markets have increased,” the statement for Alternative B suggests that the

25 basis point reduction in the target funds rate, together with the two previous policy

actions, is likely to help promote moderate growth over time. The statement notes

the modest improvement in core inflation this year but indicates that “some inflation

risks remain.” Rather than provide an explicit assessment of the balance of risks, the

statement concludes that uncertainty around the outlook for growth and inflation has

increased and that the Committee will “continue to assess the effects of financial and

other developments” and act as needed to foster its dual objectives.

(19) Market participants appear to place about two-thirds odds on a 25 basis

point reduction in the target at this meeting, with most of the remaining probability


assigned to a 50 basis point move. As a result, short-term interest rates would likely

rise modestly in response to Alternative B. However, judging from the Desk’s survey

of dealers, the statement under Alternative B would likely be read as broadly

consistent with market expectations for additional policy easing. Consequently,

longer-term interest rates, equity prices, and the foreign exchange value of the dollar

probably would be little changed.

(20) If the Committee views the renewed deterioration in financial markets and

the sharper contraction in the housing sector as presenting a particularly severe threat

to the economic expansion, it might want to lower the target funds rate 50 basis

points, as in Alternative A. A 50 basis point reduction in the federal funds rate

would put the real funds rate close to the Greenbook-consistent measure of its

equilibrium value (Chart 5) and thus, under the baseline projection, would be

consistent with output returning to its potential in the medium term. A reduction of

this size would also be broadly compatible with the optimal policy simulations with a

2 percent inflation objective (Chart 6) and some of the simple policy rules with that

goal (Chart 7). Moreover, given the deterioration in term funding markets and

increased concerns about balance sheet capacity and counterparty credit risk, the

Committee might worry about the potential for substantial additional tightening of

banks’ lending terms and standards, particularly if it viewed the arrangement of swap

lines with foreign central banks and implementation of a Term Auction Facility as

unlikely to provide significant relief to funding markets. Members might also see

incoming evidence of a deepening contraction in the housing sector, as well as the

apparent softening in business and consumer spending, as presenting unacceptably

large downside risks to overall economic activity. By contrast, incoming core inflation

data have continued to be moderate, and the Committee may see the inflation

outlook, and the associated risks, as essentially unchanged. In these circumstances,

members might conclude that the weaker modal outlook for growth and significantly


increased downside risks warrant a 50 basis point policy move at this meeting.

Members may believe that the Committee would be able to reverse the easing quickly

if appropriate.

(21) The draft statement for Alternative A begins with a reference to the further

intensification of the housing correction and recent weakening in business and

consumer expenditures, and it also mentions increased strains in financial markets. It

then notes that the outlook for economic growth has weakened somewhat and, unlike

Alternative B, adds that the downside risks to growth have increased. But as in the

other alternatives, the statement suggests that the easing in policy should help foster

moderate expansion over time. The paragraph regarding inflation is little changed

from October. The risk assessment would indicate that the 50 basis point easing

brings the risks to inflation and growth roughly into balance. But if the Committee

believes that, even after such a move, recent developments in financial markets have

increased the uncertainty around the outlook for growth and inflation to such an

extent that an assessment is not meaningful, it may wish instead to employ the risk

assessment language used in Alternative B.

(22) Investors attach significant odds to both a 50 basis point easing and a

25 basis point reduction in the target funds rate at this meeting, and so the larger

move would push very short-term interest rates lower. However, while the magnitude

of the surprise with respect to the target funds rate would be similar to that

experienced in September, the assessment that the risks to growth and inflation are

balanced, which differs notably from the language in the September statement, might

temper the reaction in rates further out the term structure. Indeed, if investors find

that assessment somewhat persuasive, intermediate- and longer-term interest rates

might increase as market participants revised up their outlook for the economy. The

equity market might rally modestly in reaction to lower interest rates and an improved


outlook for earnings, and the foreign exchange value of the dollar could even firm a

bit if market participants revised up their outlook for the U.S. economy.

(23) If the Committee judges that the current stance of policy is likely to foster

sustainable growth and acceptable inflation over time, then it might be inclined to

choose Alternative C. Members might read the incoming macroeconomic data as

broadly consistent with the outlook underlying its October policy decision, including

the expectation for a period of relatively slow growth late this year and early next year.

Conditions in short-term funding markets have deteriorated notably over the

intermeeting period and credit has tightened further for some households and

businesses, increasing the downside risks to growth. However, the Committee might

feel that the adverse effects of such developments are likely to be limited and that its

earlier easing actions—and perhaps arrangement of swap lines with foreign central

banks and implementation of a Term Auction Facility—provide ample insurance.

Moreover, members may be concerned that the unsettled state of financial markets

may make it difficult for Committee to quickly reverse further policy easing, even if

the prospects for economic growth improve. And, although core inflation has stayed

moderate and the baseline outlook for inflation may be viewed as acceptable,

members may view elevated oil and other commodity prices and a weaker dollar as

posing large enough upside risks to inflation to make an immediate reduction in the

target funds rate problematic. Under these circumstances, the Committee might see

maintenance of the current stance of policy for now as appropriate but judge that

downside risks to growth have become the dominant concern. Such an approach

would leave the Committee well placed to see whether financial market strains

diminish significantly after year-end and to accumulate additional information on the

outlook for growth and inflation before deciding whether further policy easing should

be implemented.


(24) The proposed statement for Alternative C acknowledges that economic

growth appears to be slowing but indicates explicitly that the softening is broadly in

line with what the Committee had anticipated. It then notes the increase in financial

market strains and acknowledges that they pose greater downside risk to growth, but

suggests that the monetary policy easing already in place is likely to promote moderate

expansion over time. The wording on inflation closely follows the October

statement. The draft statement then suggests that downside risks to growth are the

predominant concern and concludes with the language used in the August and earlier

statements that “future policy adjustments will depend on the outlook for both

inflation and economic growth, as implied by incoming information.”

(25) Market participants would be very surprised if the Committee kept the

target at 4½ percent at this meeting. Despite the assessment that downside risks to

growth predominate, the absence of action at this meeting and the overall tone of the

policy statement would likely suggest to investors that the Committee does not expect

to lower rates to the extent currently implied by money market futures quotes, so

short-term interest rates would increase notably on the announcement. However, the

rise in longer-term rates might be tempered if investors revised down their outlook

for economic activity and inflation. The foreign exchange value of the dollar would

likely appreciate somewhat with the backup in interest rates. Equity prices probably

would fall.

Money and Debt Forecasts

(26) Under the Greenbook projection, M2 is forecast to grow at about a

5½ percent rate on average in the current quarter, down about ¼ percentage point

from the previous forecast, reflecting in part weaker nominal GDP in the fourth

quarter. Over 2008, M2 is projected to expand at about a 4½ percent pace, a bit

above the rate of growth of nominal GDP and slightly faster than the forecast in the


50 bp Easing 25 bp Easing No Change Greenbook Forecast*

Monthly Growth RatesJul-07 4.1 4.1 4.1 4.1

Aug-07 10.6 10.6 10.6 10.6Sep-07 5.2 5.2 5.2 5.2Oct-07 4.0 4.0 4.0 4.0

Nov-07 5.1 5.1 5.1 5.1Dec-07 6.2 6.0 5.8 6.0Jan-08 5.7 5.1 4.5 5.1Feb-08 4.9 4.1 3.3 4.1Mar-08 5.2 4.5 3.8 4.5Apr-08 5.7 5.1 4.5 5.1May-08 5.2 4.8 4.3 4.8Jun-08 4.3 3.9 3.5 3.9

Quarterly Growth Rates2007 Q1 7.3 7.3 7.3 7.32007 Q2 6.5 6.5 6.5 6.52007 Q3 5.1 5.1 5.1 5.12007 Q4 5.5 5.5 5.5 5.52008 Q1 5.5 5.0 4.5 5.02008 Q2 5.3 4.7 4.1 4.7

Annual Growth Rates2007 6.2 6.2 6.2 6.22008 4.9 4.5 4.2 4.52009 4.2 4.2 4.2 4.4

Growth From ToNov-07 Mar-08 5.6 5.0 4.4 5.0Nov-07 Jun-08 5.4 4.8 4.3 4.8

2007 Q2 2007 Q4 5.4 5.4 5.3 5.42007 Q2 2008 Q2 5.5 5.2 4.9 5.2

* This forecast is consistent with nominal GDP and interest rates in the Greenbook forecast.

Alternative Growth Rates for M2Table 2

(percent, annual rate)


October Bluebook. The upward revision reflects lower opportunity costs, given the

reduction in the federal funds rate assumed in this Greenbook, as well as somewhat

greater demand for monetary assets in view of the turbulence in financial markets.

M2 is expected to continue to advance at around 4½ percent pace in 2009, a bit above

nominal GDP growth, supported by the additional policy easing assumed in that year.

(27) After having expanded at an annual rate of 7½ percent in the first half of

the year, domestic nonfinancial debt is expected to increase at about an 8 percent pace

in the second half of 2007 before slowing sharply to a 4¾ percent rate in 2008 and

2009. The deceleration in total nonfinancial sector debt reflects a projected slowdown

in borrowing across all major sectors except the federal government. The staff

expects household debt growth to fall to 6 percent at an annual rate in the second half

of this year and to 3½ percent in 2008 and to 3¼ percent in 2009, which would be the

slowest annual rate of growth in real terms since 1991. The slowdown reflects a

moderation in mortgage debt in response to declining home prices and a reduction in

home sales. Consumer credit is expected to advance at a modest pace. Nonfinancial

business debt, which expanded robustly in the third quarter, is projected to decelerate

somewhat over the forecast period, as the demand for funds to finance LBOs and

share repurchases continues to abate.


Directive

(28) Draft language for the directive is provided below.

Directive Wording The Federal Open Market Committee seeks monetary and financial

conditions that will foster price stability and promote sustainable growth

in output. To further its long-run objectives, the Committee in the

immediate future seeks conditions in reserve markets consistent with

MAINTAINING/INCREASING/reducing the federal funds rate

AT/to an average of around ________ 4 ½percent.


Appendix A: Measures of the Equilibrium Real Rate

The equilibrium real rate is the real federal funds rate that, if maintained, would be projected to return output to its potential level over time. The short-run equilibrium rate is defined as the rate that would close the output gap in twelve quarters given the corresponding model’s projection of the economy. The medium-run concept is the value of the real federal funds rate projected to keep output at potential in seven years, under the assumption that monetary policy acts to bring actual and potential output into line in the short run and then keeps them equal thereafter. The TIPS-based factor model measure provides an estimate of market expectations for the real federal funds rate seven years ahead. The actual real federal funds rate is constructed as the difference between the nominal rate and realized inflation, where the nominal rate is measured as the quarterly average of the observed federal funds rate, and realized inflation is given by the log difference between the core PCE price index and its lagged value four quarters earlier. For the current quarter, the nominal rate is specified as the target federal funds rate on the Bluebook publication date. For the current quarter and the previous quarter, the inflation rate is computed using the staff’s estimate of the core PCE price index. Confidence intervals reflect uncertainties about model specification, coefficients, and the level of potential output. The final column of the table indicates the values published in the previous Bluebook.

Measure Description Single-equation

Model The measure of the equilibrium real rate in the single-equation model is based on an estimated aggregate-demand relationship between the current value of the output gap and its lagged values as well as the lagged values of the real federal funds rate.

Small Structural Model

The small-scale model of the economy consists of equations for five variables: the output gap, the equity premium, the federal budget surplus, the trend growth rate of output, and the real bond yield.

Large Model (FRB/US)

Estimates of the equilibrium real rate using FRB/US—the staff’s large-scale econometric model of the U.S. economy—depend on a very broad array of economic factors, some of which take the form of projected values of the model’s exogenous variables.

Greenbook-consistent

The FRB/US model is used in conjunction with an extended version of the Greenbook forecast to derive a Greenbook-consistent measure. FRB/US is first add-factored so that its simulation matches the extended Greenbook forecast, and then a second simulation is run off this baseline to determine the value of the real federal funds rate that closes the output gap.

TIPS-based Factor Model

Yields on TIPS (Treasury Inflation-Protected Securities) reflect investors’ expectations of the future path of real interest rates, but also include term and liquidity premiums. The TIPS-based measure of the equilibrium real rate is constructed using the seven-year-ahead instantaneous real forward rate derived from TIPS yields as of the Bluebook publication date. This forward rate is adjusted to remove estimates of the term and liquidity premiums based on a three-factor arbitrage-free term-structure model applied to TIPS yields, nominal yields, and inflation. Because TIPS indexation is based on the total CPI, this measure is also adjusted for the medium-term difference—projected at 40 basis points—between total CPI inflation and core PCE inflation.


Appendix B: Analysis of Policy Paths and Confidence Intervals

Rule Specifications: For the following rules, it denotes the federal funds rate for quarter t, while the explanatory variables include the staff’s projection of trailing four-quarter core PCE inflation (πt), inflation two and three quarters ahead (πt+2|t and πt+3|t), the output gap in the current period and one quarter ahead ( *

t ty y− and *1| 1|t t t ty y+ +− ), and the three-quarter-ahead forecast of annual average GDP growth relative to

potential ( 4 4 *3| 3|t t t ty y+ +Δ − Δ ), and *π denotes an assumed value of policymakers’ long-run inflation

objective. The outcome-based and forecast-based rules were estimated using real-time data over the sample 1988:1-2006:4; each specification was chosen using the Bayesian information criterion. Each rule incorporates a 75 basis point shift in the intercept, specified as a sequence of 25 basis point increments during the first three quarters of 1998. The first two simple rules were proposed by Taylor (1993, 1999), while the third is a variant of the Taylor (1999) rule—introduced in the August Bluebook—with a higher value of r*. The prescriptions of the first-difference rule do not depend on assumptions regarding r* or the level of the output gap; see Orphanides (2003).

Outcome-based rule it = 1.20it-1–0.39it-2+0.19[1.17 + 1.73 πt + 3.66( *t ty y− ) – 2.72( *

1 1t ty y− −− )]

Forecast-based rule it = 1.18it-1–0.38it-2+0.20[0.98 +1.72 πt+2|t+2.29( *1| 1|t t t ty y+ +− )–1.37( *

1 1t ty y− −− )]

Taylor (1993) rule it = 2 + πt + 0.5(πt – *π ) + 0.5( *t ty y− )

Taylor (1999) rule it = 2 + πt + 0.5(πt – *π ) + ( *t ty y− )

Taylor (1999) rule with higher r*

it = 2.75 + πt + 0.5(πt – *π ) + ( *t ty y− )

First-difference rule it = it-1 + 0.5(πt+3|t – *π ) + 0.5( 4 4 *3| 3|t t t ty y+ +Δ − Δ )

FRB/US Model Simulations: Prescriptions from the two empirical rules are computed using dynamic simulations of the FRB/US model, implemented as though the rule were followed starting at this FOMC meeting. The dotted line labeled “Previous Bluebook” is based on the current specification of the policy rule, applied to the previous Greenbook projection. Confidence intervals are based on stochastic simulations of the FRB/US model with shocks drawn from the estimated residuals over 1986-2005. Information from Financial Markets: The expected funds rate path is based on forward rate agreements, and the confidence intervals for this path are constructed using prices of interest rate caps. Near-Term Prescriptions of Simple Policy Rules: These prescriptions are calculated using Greenbook projections for inflation and the output gap. Because the first-difference rule involves the lagged funds rate, the value labeled “Previous Bluebook” for the current quarter is computed using the actual value of the lagged funds rate, and the one-quarter-ahead prescriptions are based on this rule’s prescription for the current quarter.

References: Taylor, John B. (1993). “Discretion versus policy rules in practice,” Carnegie-Rochester Conference Series on Public Policy, vol. 39 (December), pp. 195-214. ————— (1999). “A Historical Analysis of Monetary Policy Rules,” in John B. Taylor, ed., Monetary Policy Rules. The University of Chicago Press, pp. 319-341. Orphanides, Athanasios (2003). “Historical Monetary Policy Analysis and the Taylor Rule,” Journal of Monetary Economics, vol. 50 (July), pp. 983-1022.


Short-term Long-term

Federalfunds

Treasury billssecondary market

CDssecondary

market

Comm.paper Off-the-run Treasury yields Indexed yields Moody’s

Baa

MunicipalBondBuyer

Conventional homemortgages

primary market

4-week 3-month 6-month 3-month 1-month 2-year 5-year 10-year 20-year 5-year 10-year Fixed-rate ARM

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

5.34 5.27 5.13 5.33 5.50 5.32 5.32 5.20 5.32 5.45 2.63 2.68 6.94 5.31 6.80 5.834.22 3.91 4.17 4.37 4.50 4.22 4.34 4.28 4.42 4.59 1.82 1.94 6.08 4.52 6.10 5.15

5.41 5.27 5.19 5.19 5.77 5.30 5.12 5.16 5.33 5.44 2.77 2.81 6.86 4.77 6.74 5.844.22 2.39 2.99 3.22 4.77 4.34 2.90 3.30 4.01 4.32 1.05 1.56 6.09 4.27 5.96 5.40

5.24 4.86 4.98 5.07 5.32 5.23 4.68 4.50 4.63 4.79 2.27 2.27 6.22 4.54 6.14 5.45

5.25 4.92 5.11 5.15 5.32 5.22 4.88 4.72 4.83 4.96 2.45 2.45 6.34 4.55 6.22 5.475.26 5.18 5.16 5.16 5.31 5.22 4.85 4.68 4.80 4.94 2.33 2.38 6.28 4.53 6.29 5.515.26 5.22 5.08 5.10 5.30 5.23 4.62 4.46 4.65 4.83 2.04 2.20 6.27 4.41 6.16 5.445.25 4.99 5.01 5.07 5.31 5.23 4.71 4.57 4.77 4.96 2.11 2.28 6.39 4.47 6.18 5.455.25 4.81 4.87 4.98 5.31 5.22 4.79 4.64 4.82 4.99 2.25 2.39 6.39 4.49 6.26 5.525.25 4.51 4.74 4.95 5.33 5.24 5.01 5.00 5.17 5.30 2.66 2.69 6.70 4.73 6.66 5.685.26 4.80 4.96 5.04 5.32 5.23 4.84 4.86 5.08 5.20 2.62 2.66 6.65 4.69 6.70 5.715.02 4.19 4.32 4.55 5.49 5.24 4.36 4.44 4.80 5.02 2.43 2.48 6.65 4.58 6.57 5.674.94 3.77 4.00 4.20 5.46 4.94 4.06 4.18 4.63 4.86 2.18 2.29 6.59 4.45 6.38 5.664.76 3.80 4.00 4.16 5.08 4.70 3.99 4.16 4.63 4.85 2.05 2.23 6.48 4.33 6.38 5.684.49 3.70 3.36 3.58 4.97 4.48 3.36 3.67 4.30 4.58 1.41 1.83 6.40 4.40 6.21 5.48

4.72 3.58 3.96 4.16 5.23 4.72 4.04 4.21 4.67 4.88 2.16 2.29 6.55 4.36 6.37 5.584.75 3.89 4.11 4.28 5.21 4.72 4.19 4.34 4.77 4.96 2.24 2.36 6.57 4.36 6.40 5.734.74 3.74 4.04 4.21 5.12 4.76 4.04 4.20 4.68 4.90 2.07 2.27 6.49 4.33 6.40 5.764.76 3.87 3.95 4.07 4.96 4.71 3.81 4.00 4.50 4.74 1.88 2.10 6.37 4.27 6.33 5.664.67 3.93 3.87 4.00 4.80 4.51 3.82 4.00 4.50 4.73 1.82 2.06 6.39 4.34 6.26 5.574.36 3.73 3.52 3.78 4.86 4.49 3.61 3.87 4.44 4.71 1.58 1.93 6.41 4.47 6.24 5.504.53 3.81 3.40 3.65 4.90 4.49 3.47 3.76 4.36 4.63 1.50 1.89 6.42 4.46 6.24 5.504.51 3.67 3.24 3.41 5.04 4.49 3.13 3.51 4.21 4.52 1.24 1.73 6.39 4.39 6.20 5.424.55 3.58 3.10 3.35 5.15 4.45 3.07 3.43 4.12 4.42 1.20 1.68 6.37 4.32 6.10 5.43 -- 3.26 3.07 3.26 5.20 4.42 2.93 3.33 4.12 4.45 1.19 1.73 -- -- 5.96 5.46

4.51 3.65 3.25 3.41 5.01 4.50 3.18 3.54 4.23 4.54 1.26 1.75 6.41 -- -- --4.50 3.55 3.09 3.28 5.06 4.47 3.03 3.45 4.20 4.51 1.20 1.72 6.41 -- -- --4.50 -- -- -- -- -- -- -- -- -- -- -- -- -- -- --4.56 3.68 3.23 3.39 5.07 4.46 3.11 3.49 4.19 4.49 1.20 1.70 6.38 -- -- --4.62 3.60 3.14 3.34 5.12 4.47 2.94 3.30 4.01 4.32 1.05 1.56 6.23 -- -- --4.39 3.68 3.16 3.37 5.11 4.48 3.07 3.42 4.13 4.43 1.18 1.67 6.36 -- -- --4.53 3.54 3.05 3.38 5.16 4.42 3.20 3.53 4.20 4.48 1.32 1.77 6.43 -- -- --4.55 3.40 2.99 3.30 5.16 4.44 3.09 3.44 4.12 4.42 1.22 1.68 6.40 -- -- --4.66 3.67 3.15 3.37 5.20 4.46 3.06 3.44 4.16 4.47 1.22 1.71 6.44 -- -- --4.52 3.64 3.06 3.28 5.23 4.46 2.91 3.31 4.08 4.41 1.15 1.67 6.41 -- -- --4.50 3.16 3.07 3.22 5.23 4.46 2.90 3.30 4.08 4.41 1.17 1.70 6.42 -- -- --4.31 3.16 3.07 3.24 5.18 4.34 2.90 3.31 4.11 4.45 1.22 1.78 6.50 -- -- --4.47 3.09 3.09 3.29 5.17 -- 3.03 3.41 4.20 4.54 1.33 1.85 -- -- -- --

Appendix C Table 1

Selected Interest Rates(Percent)

NOTE: Weekly data for columns 1 through 13 are week-ending averages. Columns 2 through 4 are on a coupon equivalent basis. Data in column 6 are interpolated from data on certain commercial paper trades settled by theDepository Trust Company. Column 14 is the Bond Buyer revenue index, which is a 1-day quote for Thursday. Column 15 is the average contract rate on new commitments for fixed-rate mortgages (FRMs) with 80 percentloan-to-value ratios at major institutional lenders. Column 16 is the average initial contract rate on new commitments for 1-year, adjustable-rate mortgages (ARMs) at major institutional lenders offering both FRMs andARMs with the same number of discount points.

p - preliminary data

Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov

Oct Oct Oct Oct Nov Nov Nov Nov Nov Dec

Nov Nov Nov Nov Nov Nov Nov Nov Nov Dec Dec Dec Dec

06

0707070707070707070707

5121926

29

162330

7

202122232627282930

3456

07070707070707070707

07070707070707070707070707

06 -- High-- Low

07 -- High-- Low

Monthly

Weekly

Daily

p

MFMA


Appendix C Table 2Money Aggregates

Seasonally Adjusted

NontransactionsComponents in M2

M1 M2

1 2 3

Period

Annual growth rates (%):

Annually (Q4 to Q4)2004 5.4 5.4 5.32005 0.3 4.2 5.32006 -0.4 4.9 6.3

Quarterly (average)2006-Q4 -0.2 6.3 7.92007-Q1 -0.4 7.3 9.1

Q2 2.3 6.5 7.5Q3 -1.6 5.1 6.7

Monthly2006-Nov. 1.3 6.0 7.2

Dec. -4.3 6.9 9.6

2007-Jan. 5.2 9.4 10.4Feb. -9.8 3.8 7.1Mar. 8.0 9.5 9.8Apr. 8.4 9.0 9.2May 0.0 3.3 4.0June -10.8 2.0 5.0July 2.5 4.1 4.4Aug. 0.4 10.6 13.0Sep. -0.6 5.2 6.6Oct. 0.7 4.0 4.8Nov. e -4.7 5.1 7.3

Levels ($billions):

Monthly2007-June 1366.9 7250.0 5883.1

July 1369.8 7274.5 5904.7Aug. 1370.2 7338.9 5968.7Sep. 1369.5 7370.8 6001.3Oct. 1370.3 7395.6 6025.3

Weekly2007-Oct. 1 1356.4 7384.0 6027.6

8 1374.2 7385.1 6010.915 1374.6 7372.7 5998.122 1358.3 7382.9 6024.629 1364.5 7427.1 6062.6

Nov. 5 1392.8 7406.4 6013.612 1371.6 7403.0 6031.419p 1351.4 7424.1 6072.726p 1355.0 7464.6 6109.6

p preliminar ye estimated


Appendix C Table 3

Changes in System Holdings of Securities 1

(Millions of dollars, not seasonally adjusted)

December 6, 2007

Treasury Bills Treasury Coupons Federal Net change Net RPs 5

Agency totalNet Redemptions Net Net Purchases 3 Redemptions Net Redemptions outright Short- Long- Net

Purchases 2 (-) Change < 1 1-5 5-10 Over 10 (-) Change (-) holdings 4 Term 6 Term 7 Change

2004 18,138 --- 18,138 7,994 17,249 5,763 1,364 --- 32,370 --- 50,507 -2,522 -331 -2,853

2005 8,300 --- 8,300 2,894 11,309 3,626 2,007 2,795 17,041 --- 25,341 -2,415 -192 -2,607

2006 5,748 --- 5,748 4,967 26,354 4,322 3,299 10,552 28,390 --- 34,138 -2,062 -556 -2,618

2006 QIII 1,649 --- 1,649 415 3,323 548 228 3,931 583 --- 2,232 -3,229 -839 -4,068

QIV --- --- --- 1,977 9,525 889 1,852 4,084 10,159 --- 10,159 -2,379 4,848 2,469

2007 QI --- --- --- 817 1,061 --- --- --- 1,878 --- 1,878 -2,815 1,059 -1,755

QII --- --- --- 1,394 6,478 290 640 --- 8,802 --- 8,802 1,520 -4,673 -3,153

QIII --- 10,000 -10,000 --- --- --- --- 1,236 -1,236 --- -11,236 6,579 -2,550 4,030

2007 Apr --- --- --- 1,394 3,742 290 640 --- 6,066 --- 6,066 1,250 -2,425 -1,174

May --- --- --- --- 2,736 --- --- --- 2,736 --- 2,736 2,165 -4,930 -2,765

Jun --- --- --- --- --- --- --- --- --- --- --- -331 97 -234

Jul --- --- --- --- --- --- --- --- --- --- --- 1,600 -903 697

Aug --- 10,000 -10,000 --- --- --- --- 1,236 -1,236 --- -11,236 2,888 677 3,565

Sep --- --- --- --- --- --- --- --- --- --- --- 7,890 -1,641 6,250

Oct --- --- --- --- --- --- --- --- --- --- --- 3,000 -940 2,060

Nov --- --- --- --- --- --- --- --- --- --- --- 411 6,906 7,318

2007 Sep 12 --- --- --- --- --- --- --- --- --- --- --- -3,003 --- -3,003

Sep 19 --- --- --- --- --- --- --- --- --- --- --- -4,622 --- -4,622

Sep 26 --- --- --- --- --- --- --- --- --- --- --- 9,525 --- 9,525

Oct 3 --- --- --- --- --- --- --- --- --- --- --- 1,682 1,000 2,682

Oct 10 --- --- --- --- --- --- --- --- --- --- --- 72 -3,000 -2,928

Oct 17 --- --- --- --- --- --- --- --- --- --- --- 373 --- 373

Oct 24 --- --- --- --- --- --- --- --- --- --- --- -5,108 2,000 -3,108

Oct 31 --- --- --- --- --- --- --- --- --- --- --- 2,131 --- 2,131

Nov 7 --- --- --- --- --- --- --- --- --- --- --- 412 2,000 2,412

Nov 14 --- --- --- --- --- --- --- --- --- --- --- -457 3,000 2,543

Nov 21 --- --- --- --- --- --- --- --- --- --- --- 4,691 429 5,119

Nov 28 --- --- --- --- --- --- --- --- --- --- --- -2,804 3,714 911

Dec 5 --- --- --- --- --- --- --- --- --- --- --- -10,140 6,857 -3,283

2007 Dec 6 --- 5,000 -5,000 --- --- --- --- --- --- --- -5,000 7,211 -8,000 -789

Intermeeting Period

Oct 31-Dec 6 --- 5,000 -5,000 --- --- --- --- --- --- --- -5,000 -7,533 8,000 467

Memo: LEVEL (bil. $)

Dec 6 262.0 107.3 234.7 81.9 88.8 512.7 --- 774.7 -10.9 20.0 9.1

1. Change from end-of-period to end-of-period. Excludes changes in compensation for the effects of 4. Includes redemptions (-) of Treasury and agency securities. inflation on the principal of inflation-indexed securities. 5. RPs outstanding less reverse RPs.2. Outright purchases less outright sales (in market and with foreign accounts). 6. Original maturity of 13 days or less.3. Outright purchases less outright sales (in market and with foreign accounts). Includes short-term notes 7. Original maturity of 14 to 90 days. acquired in exchange for maturing bills. Excludes maturity shifts and rollovers of maturing issues, except the rollover of inflation compensation.

MRA:HJR


Appendix C Chart 1

Treasury Yield Curve

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

−4

−2

0

2

4Percentage points

+ Denotes most recent weekly value.Note. Blue shaded regions denote NBER−dated recessions.

+

Spread Between Ten−Year Treasury Yield and Federal Funds Rate

Quarterly

1 3 5 7 10 20

3

4

5

6Percent

December 6, 2007 October 30, 2007

Treasury Yield Curve*

Maturity in Years*Smoothed yield curve estimated from off−the−run Treasury coupon securities. Yields shown are those on notional par Treasury securities with semi−annual coupons.


Appendix C Chart 2

Dollar Exchange Rate Indexes

1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 60

80

100

120

140

160

Ratio scaleMarch 1973=100

+ Denotes most recent weekly value.

+

Nominal

Major Currencies

Monthly

1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006

80

90

100

110

120

130

140

Ratio scaleMarch 1973=100

Real

MajorCurrencies

Broad

Other Important

Monthly

Note. The major currencies index is the trade−weighted average of currencies of the euro area, Canada, Japan, the U.K., Switzerland, Australia, and Sweden. The other important trading partners index is the trade−weighted average of currencies of 19 other important trading partners. The Broad index is the trade−weighted average of currencies of all important trading partners. Real indexes have been adjusted for relative changes in U.S. and foreign consumer prices. Blue shaded regions denote NBER−dated recessions. The most recent monthly observations are based on staff forecasts of CPI inflation for those countries where actual data are not yet available.


Appendix C Chart 3

Stock Indexes

0

5

10

15

20

25

30

35

40

45

50Ratio

+

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

125

250

500

1000

1500

2000

Ratio scale1941−43=10

* Based on trailing four−quarter earnings.+ Denotes most recent weekly value.

+

Nominal

Monthly

P/E Ratio*

S&P 500

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004

20

40

60

80

100

120

140160

Ratio scale1941−43=10

* Deflated by the CPI.+ Denotes most recent weekly value.Note. Blue shaded regions denote NBER−dated recessions.

+

Real

Monthly

S&P 500*


Appendix C Chart 4

One−Year Real Interest Rates

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007−4

0

4

8Percent

* Mean value of respondents.

+

Monthly

One−Year Treasury Constant Maturity Yield Less One−Year Inflation Expectations (Michigan Survey)*

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007−4

0

4

8Percent

* ASA/NBER quarterly survey until 1990:Q1; Philadelphia Federal Reserve Bank Survey of Professional Forecastersthereafter. Median value of respondents.

++

GDP Deflator

CPI

Monthly

One−Year Treasury Constant Maturity Yield Less One−Year Inflation Expectations (Philadelphia Fed)*

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007−4

0

4

8Percent

+ Denotes most recent weekly Treasury constant maturity yield less most recent inflation expectation.Note. Blue shaded regions denote NBER−dated recessions.

+

Monthly

One−Year Treasury Constant Maturity Yield Less Change in the Core CPI from Three Months Prior


Appendix C Chart 5

Long−Term Real Interest Rates*

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 0

2

4

6

8

10Percent

+

+

+

Monthly

Real Ten−Year Treasury Yields

Real rate usingPhiladelphia Fed Survey

Real rate usingMichigan Survey

Ten−year TIPS yield

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

2

4

6

8

10

12

14Percent

+

++

Nominal and Real Corporate Bond Rates

Monthly

Nominal rate on Moody’sA−rated corporate bonds

Real rate usingPhiladelphia Fed Survey

Real rate usingMichigan Survey

* For real rates, measures using the Philadelphia Fed Survey employ the ten−year inflation expectations from the Blue Chip Survey until April 1991 and the Philadelphia Federal Reserve Bank Survey of Professional Forecasters thereafter (median value of respondents). Measures using the Michigan Survey employ the five− to ten−year inflation expectations from that survey (mean value of respondents).

+ For TIPS and nominal corporate rate, denotes the most recent weekly value. For other real rate series, denotes the most recent weekly nominal yield less the most recent inflation expectation. Note. Blue shaded regions denote NBER−dated recessions.


Appendix C Chart 6

Commodity Price Measures

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

100

150

200

250Ratio scale, index (1980=100)

Journal of Commerce Index

Weekly

TotalMetals

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

250

300

350

400

450

500


CRB Spot Industrials

Weekly

1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007

200

250

300

350

400

450


Note. Blue shaded regions denote NBER−dated recessions.

CRB Futures

Weekly


Appendix C Chart 7

Growth of M2

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 0

2

4

6

8

10

12

14Percent

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 0

2

4

6

8

10

12

14Percent

Nominal M2

Quarterly

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008

−5

0

5

10Percent

1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008

−5

0

5

10Percent

Real M2

Quarterly

Note. Four−quarter moving average. Blue shaded regions denote NBER−dated recessions. Gray areas denote projection period. Real M2 is deflated by CPI.


Appendix C Chart 8

Inflation Indicator Based on M2

Note: P* is defined to equal M2 times V* divided by potential GDP. V*, or long-run velocity, is estimatedusing average velocity over the 1959:Q1-to-1989:Q4 period and then, after a break, over the interval from1993:Q1 to the present. For the forecast period, P* is based on the staff M2 forecast and P is simulated using ashort-run dynamic model relating P to P*. Blue areas indicate periods in which P* is notably less than P.Gray areas denote the projection period.

1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

40

60

80

100

120

140

160Ratio scalePrice Level

Quarterly

Implicit GDPprice deflator (P) Long-run equilibrium

price level (P*)

1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

40

60

80

100

120

140

160Ratio scale

1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

2

4

6

8

10

12PercentInflation 1

Quarterly

1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007

2

4

6

8

10

12Percent

1. Change in the implicit GDP price deflator over the previous four quarters.


fomc 20071211 blue book 20071206

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